Starbucks And Franchising Make Sense

Once upon a time in a previous career, I helped people buy franchises. One of the first questions I usually heard from clients was how could they buy a Tim Hortons (NYSE: THI) franchise, especially those wanting to operate their business in Canada. Timmy's is a household name here. That'll never change. I myself prefer Starbucks (Nasdaq: SBUX). Speaking of which, the Seattle institution is turning to franchising in a big way to grow Seattle's Best Coffee, the smaller coffee brand it acquired for $72 million in 2003. I personally think it's a great idea. Here's why:

If you're fan of Starbucks, you know about its abysmal failure with brand extensions. It lost its mojo a few years back as it tried to be everything to everyone, and in the process it ruined the customer experience. That's thankfully a thing of the past. A visit to one of its stores today feels much like it did before it started tinkering with a proven commodity. I'm not saying it's perfect, but it's a heck of a lot better. With this in mind, now is the perfect time to deal with its other brand, which had become a business lacking direction. Was it a retail store or a wholesale operation? Nobody knew. Company veteran Michelle Gass has taken over as president, and good things are sure to happen.

Business Opportunity

Over the next three years, Tim Hortons plans to add 300 stores in Michigan, Ohio and New York to its existing store base of 563. It plans to go after Starbucks and Dunkin' Donuts in those three markets with upscale coffee shops that are a step up from its existing store design. It believes it can take business from the two behemoths that operate over 17,000 outlets in the U.S. alone. With projected same-store sales growth in its U.S. stores of 2-4% in 2010, it'll hold its own, but I'm doubtful it will make a dent in either of its competitors' businesses. This is where Seattle's Best Coffee comes in. At present, if I were to consider opening a coffee franchise in the U.S., I'd likely go with Dunkin' Donuts.

It's a proven name with a proven history in franchising. Tim Hortons would only be a consideration in the three states I mentioned earlier. Others, like Caribou Coffee (Nasdaq: CBOU) and The Coffee Bean, would also garner consideration. I'd love to get my hands on a Panera Bread (Nasdaq: PNRA) or McDonald's (NYSE: MCD) franchise, but you practically have to hand over your first-born child to qualify, and they don't generally award single-unit franchise agreements. This brings us back to Seattle's Best. With the purchase of a Seattle's Best franchise, you get the backing of the world's largest coffee company, a strong brand with excellent wholesale product placement and an initial investment that's lower than both Tim Hortons and Dunkin' Donuts. Remember, Starbucks doesn't franchise, so this is the next best thing.

Cheaper Growth

Starbucks has 4% of U.S. coffee sales. That's it. When you take into account the sales of Green Mountain Coffee (Nasdaq: GMCR), Folgers, Maxwell House and all the others that are hawking beans, it becomes abundantly clear that there is room for Starbucks to grow - both by taking market share and by the pie simply increasing as more and more people take to drinking coffee and tea. Starbucks obviously will continue to open its own stores, but why not spread some of the retail risk to interested franchisees? Doing so allows it to reallocate the capital expenditure savings to its global consumer products group, which generates just 8% of overall revenues but 33% of operating income. Any growth in this area is pure profit.

Bottom Line

Starbucks has a smart business plan for Seattle's Best Coffee. With the proper execution, this could be huge for shareholders. A year from now, we'll have a good idea how huge. (Learn the contract specifications for a few of the most heavily traded commodities. See The Sweet Life Of Soft Markets.)